When I first heard about the Cyprus
ritual execution bailout, I had thought that the widespread predictions that the island nation’s economy would contract by 20% to 30% over the next two years were off base.
I thought it would happen much faster, on the order of two to three months. An estimated 45% (mind you, 45%!) of the economy is banking (clarification: including services to international banking clients, such as legal and accounting), and almost all of that international banking. So if you generously assume 200% of the 900% of GDP was bona fide domestic assets (remember you have a lot of retirees), the other 7/9 goes poof. And that’s before you get to the fact that a lot of the services provided to foreign customers (the higher-end accounting and legal services) will have no future in a purely domestic banking business. So assume 90% of that 45% disappears in short order.
That much of an economy vaporizing is a state change. It’s not clear how Cyprus can regroup or recover even if the surplus international banking types could decamp. How do natives, whose money is presumably entirely in Cyprus (assuming it was not devastated by the hits to depositors at Laiki and Bank of Cyprus) emigrate with capital controls? How can they get their money out to make a new start somewhere else, if that’s their inclination? Again, while the Cypriot government initially said that capital controls would only be in place a matter of day, no expert believes that. They anticipate they’ll be in place for years to keep the remaining deposits from vanishing.
I did not make predict the speed of decline because the my assessment seemed too extreme. Surely I was missing something. Even though it looked to me as if Germany had done the economic equivalent of nuking half the island, and there would be knock-on effects from that level of devastation, I figured I had to be missing something in terms of how quickly the bad effects would take hold.
Well, maybe not. Recall that we predicted that depositors of over €100,000 in Laiki, the number two bank, would be wiped out. Reuters tells us that depositors with over €100,000 in the biggest bank, Bank of Cyprus, will have no liquidity (see boldface):
Big depositors in Cyprus’s largest bank stand to lose far more than initially feared under a European Union rescue package to save the island from bankruptcy, a source with direct knowledge of the terms said on Friday.
Under conditions expected to be announced on Saturday, depositors in Bank of Cyprus will get shares in the bank worth 37.5 percent of their deposits over 100,000 euros, the source told Reuters, while the rest of their deposits may never be paid back…
Officials had previously spoken of a loss to big depositors of 30 to 40 percent….
At Bank of Cyprus, about 22.5 percent of deposits over 100,000 euros will attract no interest, the source said. The remaining 40 percent will continue to attract interest, but will not be repaid unless the bank does well.
The over €100,000 deposits in Laiki are gone.
At the Bank of Cyprus:
The 37.5% of >€100,000 deposits being converted to shares is a seriously out of the money option. What would you value that at? Not much.
40% won’t be accessible even under a best case scenario for years. The duration of time deposits is to be determined, and any returns depends on the bank’s performance. And of course, depositors may not get it all back.
The remaining 22.5% may or may not be available in two to three months.
The New York Times’ story is broadly consistent with the Reuters account, indicating that over 60% of deposits at the Bank of Cyprus could be toast:
Under the terms of the transaction, large depositors would have 77.5 percent of their savings turned into different forms of equity, with the rest remaining as a frozen, non-interest-bearing deposit that they would be able to access in the future.
If the bank does well, depositors would be able to sell their stock. But even in the best case, in which the bank thrives on the back of a quickly recovering economy — a long shot most economists believe — the loss is likely to exceed 60 percent and could well be much more than that.
Lawyers and bankers who have analyzed the transaction believe the ultimate loss to the depositor could be anywhere between 60 and 77.5 percent.
Notice that the Times doesn’t buy the effort to pass off the “term deposit” that you maybe never see again and whose payout depends on performance as anything other than equity. It is silent on what happens to the remaining 22.5%. It does point out that nothing has been announced and final terms may therefore differ from the rumors.
Now remember, Laiki and Bank of Cyprus were the core of the payments system in Cyprus. And it would be very difficult for a business of meaningful size not to have over €100,000 in deposits. If you freeze a significant majority of the commercial balances, how can you operate? How can these businesses even survive and pay each other? By e-mail, Antonis Polemitis of Ledra Capital teased out the implications:
If the Reuters story is correct, for the purposes of liquidity on Tuesday morning, that is a 100% haircut.
If that is what they do, I am not sure how Cyprus can engage in economic activity on Tuesday without going to barter or scrips.
I mean, that basically will mean 100% of the large deposits (all the business accounts) at Laiki and BoC are lost or not available as of next week. The Laiki wipe out may have been survivable. If you wipe (for liquidity purposes at least), both Laiki and BoC, then we are not talking about whether or not GDP drops X%, we are talking about ‘how do you actually engage in commerce?’
If they do this, there is little chance it can last more than a month — the economy will simply fail at even basic functions…
And if the plan has been accurately reported and plays out as Polemitis fears, it will undermine the “Cyprus is a special case” narrative. This Eurozone fiasco is making Geithner look good. The former Treasury secretary used the need to keep the confidence fairy alive as the excuse for any and every sop to the banks, from coddling miscreant executives to foaming the runway with mortgage borrowers to stealth bailouts. But the Eurocrats have completely ignored the impact of undermining confidence in the banking system. The fact that Cyprus has a decent-sized population of English retirees means that the British media will report on the Cyprus meltdown, which will be a stark contrast with Greece, where the economic devastation has not gotten the coverage it warrants. Grim accounts of the destruction wrought by the tender ministrations of the Troika should strengthen the position of the growing Euroskeptic sentiment in Italy, borne out by the success of Berlusconi and Grillo in the recent elections. Playing into the hands of Italian refuseniks should be the last thing Brussels and Berlin want. The cost of getting tough with Cyprus is likely to be far greater than they anticipate.